Obama, Volcker: Defining the Role of Banks

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by: Tom Armistead

Paul Volcker's recent op-ed in the Financial Times shares some common lines of thought with Obama's State of the Union speech, delivered a few days earlier. The sections in question:

Volcker:

...we need to recognize that the basic operations of commercial banks are integral to a well-functioning private financial system. It is those institutions, after all, that manage and protect the basic payments systems upon which we all depend. More broadly, they provide the essential intermediating function of matching the need for safe and readily available depositories for liquid funds with the need for reliable sources of credit for businesses, individuals and governments.

Obama:

Look, I am not interested in punishing banks. I'm interested in protecting our economy. A strong, healthy financial market makes it possible for businesses to access credit and create new jobs. It channels the savings of families into investments that raise incomes. But that can only happen if we guard against the same recklessness that nearly brought down our entire economy.

On the topic of banks, the common thread here is a short form statement of their importance and proper function. The importance is self evident: banks are part of a system upon which we all depend. Their proper function is as channels or intermediaries between savers and borrowers. They must be reliable and safe.

All of this is self-evident. The importance of repeating it as an introduction to any discussion of banking is this: what it leaves out.

Defining the proper function of banks as intermediation between savers and borrowers simply does not include prop-trading, HFT, front-running, etc. Nor does it include the operation of a CDS casino, serving as a bookie for endless bets and speculative ploys aimed at every business and government on the planet.

This cuts the Gordian knot - What banks should be doing, and what entitles them to the support of the government, is very simple – take in deposits and lend the money out to borrowers. These are systems that must function reliably and safely. Anything else that banks may be interested in doing needs to pass a test: can it degenerate into recklessness that might bring down our economy?

What makes free market capitalism work is people: people who work, save and invest. Banks have an important role as intermediaries in this process. This is so important that the government is drawn in as a guarantor, explicit or implicit, it does not matter. But there is no reason on earth why the government should get sucked into guaranteeing any activity that is not consistent with the fundamental purpose and proper role of the banks.

Further, the government as unwilling guarantor has every right and indeed an obligation to taxpayers to ensure that banks properly perform their appointed role: they need to be able to return deposited funds at any time and in any amount. To do that, they must not lend money without a reasonable expectation that it will be repaid. And they must extend and maintain credit to those who meet reasonable standards of ability to repay.

This is all so simple. Why are the banks and their lobbyists able to make it so complex?

Disclosure: No stocks mentioned